TITLE:
Managing Real Estate Exposure: An Empirical Analysis on Interest Rate Risk
AUTHORS:
Cem Berk
KEYWORDS:
Real Estate, Risk Management, Derivative Contracts, Interest Rate Risk, Cointegration, Granger Causality
JOURNAL NAME:
Journal of Financial Risk Management,
Vol.6 No.3,
August
16,
2017
ABSTRACT: Real estate is an illiquid
investment with cyclical returns, so risk management techniques should be used for sustainable returns.
The risk management techniques include asset based, portfolio, insurance and
derivatives solutions. Asset based solutions include the risk character of the
real estate, based on where it’s located and how well it is developed. Some
property such as foreclosure and those require maintenance is riskier than
others. Portfolio solutions allow real estate companies to include real estate
with different location and segments such as office and retail. Using this, the
risk is limited to the systematic component, where asset based-idiosyncratic risk is tried to
be reduced when included enough number of assets to the basket. The management
should be capable of determining which risks taking and which to transfer. Some
risks such as earthquake, fire, vehicle crush, terrorist activities are rare in
nature but can cause severe damage when it takes place. The insurance policies
can cover these events which most of the time are reinsured. In addition
derivatives are available to hedge some of the risks. These can be traded on
the market or over-the-counter. By using derivatives it is possible to hedge
interest rate risk, inflation, currency risks, and property price changes. To
hedge interest rate risk which is also studied in this paper, instruments such
as cap, swap, and collar are available. The research is investigating the role
of interest rate risk in the performance of real estate management companies.
The variables used in this research are 30 years treasury yield, and exchange
closing price for CBRE Group Inc., Colliers International Group, and Jones Lang
LaSalle Incorporated. The data is daily for the period 16 June 2004 and 19 June 2015. The methods used are
Johansen Cointegration and Granger Causality. The results of the study indicate
there is a short-run and long-run relationship between interest rate and real
estate management firm stock performance. In other words, interest rate
fluctuation is a critical risk in performance of real estate management
companies. In the paper, it is also discussed risk mitigation ideas for
controlling this and other risks that real estate management industry is exposed.